A number of documents from the US have been circulating that set out the US’s ambitions for its domestic tax system and the wider international tax system. The US's international proposals could substantially change the scope of the OECD pillars project. Assuming that the US is successful in negotiating these changes, there are five key implications for how the international tax system may evolve.
1. Pillar one no longer targets tech and consumer businesses: New taxing rights allocated to market jurisdictions under pillar one proposals may no longer be focused only on automated digital service providers and consumer facing businesses. Instead, a more comprehensive scope is being proposed by the US based on revenue and profit margin, rather than targeting specific sectors. This should offer a material simplification as disputes arising from a qualitative activity test was a major concern with the original proposals. A further significant point of negotiations will be whether the US can persuade other territories to abandon their DSTs. The US calls for the proliferation of DSTs to be rolled-back could be seen as a veiled threat to walk away from the negotiating table if the US proposals are not adopted.
2. Largest 100 businesses now in the spotlight for pillar one market-jurisdiction tax: Under the US proposals, the scope of pillar one should only target the largest 100 MNEs. They are seeking quantitative criteria to bring in scope only the largest and most profitable MNE groups, regardless of industry classification or business model. This presents a significant narrowing of the OECD rules that had sought to target some 2,300 businesses. The proposed quantitative screening criteria would be based on revenue with a secondary profit margin test to capture the businesses that are most profitable, and likely to be intangibly driven and have most potential for profit shifting. No doubt this will become a major boundary issue with significant cost and compliance obligations for businesses if the tests are breached.
3. Previously excluded financial services may become in scope for pillar one: A number of specific sector exemptions were identified in pillar one focused on natural resources, certain financial services, construction, sale and leasing of property and international air and shipping businesses. Under the US proposal, these exemptions would presumably be no longer relevant. A quick look at some of the largest global businesses by revenue indicate they tend to be in energy, financial services, and the motor industry. The addition of the profit margin test may leave financial services more exposed than the others and somewhat surprised that it is suddenly within scope of pillar one.
4. Pillar two global minimum tax unaffected by pillar one’s narrowing of scope: The scope of pillar two proposals remains unchanged. As the proposals stand, the CBCR threshold has been suggested which would mean MNE groups that have a consolidated revenue threshold of €750m or more would be caught – some 2,300 businesses. Pillar two seeks to introduce a top up tax (akin to CFC rules) or deny deductions or treaty benefits if the profits or certain payments are not subject to a globally agreed minimum tax rate.
5. US signals global minimum tax of 21%: The big political question surrounding pillar two’s global minimum tax has been what an appropriate effective rate of tax is. The pillar two blueprint uses proxies in some of its examples that some have taken to suggest a rate between 10%–12% for the income inclusion top-up tax and undertaxed payment rule, and 7.5% for the subject to tax rule. Under the US proposals, the 21% default rate trigger for its SHIELD proposal could be taken as meaning what the US thinks is an acceptable minimum tax rate. For some territories that use a low corporation tax rate to encourage business to invest in their jurisdiction, a global minimum rate as high as 21% will erode any sense of their sovereignty over rates. For others, the ability to impose a top-up tax to a rate of 21% will close any remaining perceived profit shifting activity and present a new revenue stream. Somewhat contrary to expectations, the Financial Times reports that Europe’s low-tax nations have welcomed the measures, but much depends on the detail and the rate has been conspicuously parked as a point of discussion so far. Meanwhile, with the UK set to increase its corporation tax rate to 25% in 2023, we might expect the UK to fall in behind the US to support these proposals.
The OECD has said a political agreement will be reached by mid-2021 when it will deliver a global consensus-based solution to the July G20 finance ministers’ meeting. With the US back at the table proposing some serious changes to pillar one to focus on the largest 100 MNEs yet indicating its willingness to introduce a higher than anticipated global minimum tax rate, it will no doubt create equal amounts of pleasure and displeasure amongst the Inclusive Framework members. The political tensions that existed before will still be there, they may just be different now.
A number of documents from the US have been circulating that set out the US’s ambitions for its domestic tax system and the wider international tax system. The US's international proposals could substantially change the scope of the OECD pillars project. Assuming that the US is successful in negotiating these changes, there are five key implications for how the international tax system may evolve.
1. Pillar one no longer targets tech and consumer businesses: New taxing rights allocated to market jurisdictions under pillar one proposals may no longer be focused only on automated digital service providers and consumer facing businesses. Instead, a more comprehensive scope is being proposed by the US based on revenue and profit margin, rather than targeting specific sectors. This should offer a material simplification as disputes arising from a qualitative activity test was a major concern with the original proposals. A further significant point of negotiations will be whether the US can persuade other territories to abandon their DSTs. The US calls for the proliferation of DSTs to be rolled-back could be seen as a veiled threat to walk away from the negotiating table if the US proposals are not adopted.
2. Largest 100 businesses now in the spotlight for pillar one market-jurisdiction tax: Under the US proposals, the scope of pillar one should only target the largest 100 MNEs. They are seeking quantitative criteria to bring in scope only the largest and most profitable MNE groups, regardless of industry classification or business model. This presents a significant narrowing of the OECD rules that had sought to target some 2,300 businesses. The proposed quantitative screening criteria would be based on revenue with a secondary profit margin test to capture the businesses that are most profitable, and likely to be intangibly driven and have most potential for profit shifting. No doubt this will become a major boundary issue with significant cost and compliance obligations for businesses if the tests are breached.
3. Previously excluded financial services may become in scope for pillar one: A number of specific sector exemptions were identified in pillar one focused on natural resources, certain financial services, construction, sale and leasing of property and international air and shipping businesses. Under the US proposal, these exemptions would presumably be no longer relevant. A quick look at some of the largest global businesses by revenue indicate they tend to be in energy, financial services, and the motor industry. The addition of the profit margin test may leave financial services more exposed than the others and somewhat surprised that it is suddenly within scope of pillar one.
4. Pillar two global minimum tax unaffected by pillar one’s narrowing of scope: The scope of pillar two proposals remains unchanged. As the proposals stand, the CBCR threshold has been suggested which would mean MNE groups that have a consolidated revenue threshold of €750m or more would be caught – some 2,300 businesses. Pillar two seeks to introduce a top up tax (akin to CFC rules) or deny deductions or treaty benefits if the profits or certain payments are not subject to a globally agreed minimum tax rate.
5. US signals global minimum tax of 21%: The big political question surrounding pillar two’s global minimum tax has been what an appropriate effective rate of tax is. The pillar two blueprint uses proxies in some of its examples that some have taken to suggest a rate between 10%–12% for the income inclusion top-up tax and undertaxed payment rule, and 7.5% for the subject to tax rule. Under the US proposals, the 21% default rate trigger for its SHIELD proposal could be taken as meaning what the US thinks is an acceptable minimum tax rate. For some territories that use a low corporation tax rate to encourage business to invest in their jurisdiction, a global minimum rate as high as 21% will erode any sense of their sovereignty over rates. For others, the ability to impose a top-up tax to a rate of 21% will close any remaining perceived profit shifting activity and present a new revenue stream. Somewhat contrary to expectations, the Financial Times reports that Europe’s low-tax nations have welcomed the measures, but much depends on the detail and the rate has been conspicuously parked as a point of discussion so far. Meanwhile, with the UK set to increase its corporation tax rate to 25% in 2023, we might expect the UK to fall in behind the US to support these proposals.
The OECD has said a political agreement will be reached by mid-2021 when it will deliver a global consensus-based solution to the July G20 finance ministers’ meeting. With the US back at the table proposing some serious changes to pillar one to focus on the largest 100 MNEs yet indicating its willingness to introduce a higher than anticipated global minimum tax rate, it will no doubt create equal amounts of pleasure and displeasure amongst the Inclusive Framework members. The political tensions that existed before will still be there, they may just be different now.
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